Wednesdays with Wyckoff: Stock Breaking Through Resistance

Jun 1, 2011: 1:19 PM CST

I wanted to start a new series of educational posts entitled “Wednesdays with Wyckoff,” in which I will take a quote from the writings of Richard Wyckoff (of the early 1900s) and apply the lesson or idea with an example from today’s markets.

Wyckoff was one of the early fathers of Technical Analysis, and contributed much through his explanations on how supply and demand interact in the marketplace.

Today’s quote comes from his work Studies in Tape Reading (pgs. 87 and 91) which references a stock pausing at a known resistance level (the logic is the same for breaking down under support) and then breaking firmly through that level – using colorful imagery to illustrate the concept:

“[Imagine a small river running quietly on its way].  The stream is so tiny that you can place your hand in its course and the water will back up.  In five minutes, however, it overcomes this resistance by going over or around your hand.

[Then,] you fetch a shovel, pile dirt in its path, pack it down hard, and say ‘There – I’ve dammed you.’  But you haven’t at all, for the next day you find your pile of dirt washed away.

You [then] bring cartloads of dirt and build a substantial dam, and the flow is finally held in check.”

“It is the same way with an individual stock or the market — Prices follow the line of least resistance.

When a stream breaks through a dam it goes into new territory.  Likewise, the breaking through of a stock is significant, for it means that resistance has been overcome.

The stronger the resistance, the less likelihood of finding further obstacles in the immediate vicinity – dams are not usually built one behind the other.

So when we find a stock emerging into a new field, it is best to go with it.”

While there are plenty of examples to show this concept, let’s take a look at Apple’s (AAPL) intraday chart at the end of May 2011 as price challenged the overhead resistance/supply area at $337 to $338:

Envision price as a river and envision someone trying to dam up the upwardly flowing river at the $337/$338 area.  This resistance area becomes evident just by viewing price itself – no magic indicators are necessary.

Each time price rallied into resistance, sellers turned back the flowing tide until the tide proved stronger than the sellers on May 31st when price surged higher, gapping strongly/declaratively above the resistance barrier at $338 per share.

Wyckoff said it is best to go with a stock breaking into new territory (relative to its timeframe) and we see the recent resolution of the “dam breaking” through $338:

The opening candle – and gap – clearly broke the $338 resistance, and after a consolidation at the $344 per share level, the price river continued its upwardly flowing direction higher, flowing all the way to $352 on June 1st, giving intraday traders decent chances to profit from this intraday breakout situation.

We can find many more examples of this breakthrough concept in all markets and in all timeframes – though of course the higher the timeframe, the more significant the breakout.

Odds are that price will continue temporarily flowing in that direction once resistance has been cleared, which allows short-term traders to play in the direction of the breakout, perhaps by trading smaller breakouts or retracements on lower timeframes (if the breakout is on a daily or weekly chart).

Stay tuned as we study more simple yet effective lessons from Richard Wyckoff’s teachings in the coming weeks.

Corey Rosenbloom, CMT
Afraid to Trade.com

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Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

3 Comments

3 Responses to “Wednesdays with Wyckoff: Stock Breaking Through Resistance”

  1. eli_jones Says:

    great use of straight forward metaphors to apply toward attaining improved trading results.

  2. Wednesdays with Wyckoff: Trading in Dull Markets and Breakouts | Afraid to Trade.com Blog Says:

    […] Last week’s entry was a lesson – with colorful imagery – on a stock breaking through a resistance level. […]

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